Smith & Wesson Hit By a Triple-Downgrade: 3 Things You Need to Know

By Markets Fool.com

Smith & Wesson stock is getting pummeled in early Monday trading, down 15% as of this writing -- and it's not hard to see why.

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The news
In rapid succession, three Wall Street banking houses issued downgrades on Smith & Wesson stock today. Cowen and Co. sparked the route with a downgrade from outperform to market perform a couple hours before trading began for the day. Only an hour later, CL King and BB&T Capitaljumped on the anti-gun-stock bandwagon, announcing downgrades of their own -- both the equivalentof buy ratings reverting to neutral.

But why, an investor might ask, all this pessimism about Smith & Wesson, and all of a sudden? Here are three things you need to know to make sense of what's happening.


Three downgrades do violence to the gun maker. Image source: Smith & Wesson.

Thing No. 1: Survey says...
Cowen cited new data out of the FBI's National Instant Criminal Background Check System, on inquiries attendant to gun purchases by would-be buyers, as sparking its concern over Smith & Wesson stock. According to TheFly.com, Cowen noted a 13.2% sequential decline in the number of background checks related to handgun purchases in March, alongside an 8% slide in background checks for long gun purchasers. While this was only a sequential, month-on-month decline, and not as significant as a year-over-year tumble, it's still, says Cowen, the biggest such sequential slide seen in the last 10 years.

As we've previously noted, SEC filings by Smith & Wesson show the gun maker to be much more dependent (20% market share) on handgun sales, which are hurting worse than long gun sales (where S&W controls only a 6% share).

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In contrast, Sturm, Ruger controls nearly equal market shares of both handguns (16%) and rifles (14%). Curiously, its exposure to the apparent big dip in handgun sales is nearly as great as Smith & Wesson's -- yet Sturm, Ruger has not yet been downgraded.

Thing No. 2: The bigger they get, the harder they fall
What might explain this discrepancy? Well, according to data from Yahoo! Finance, Smith & Wesson shares have more than doubled over the past year -- up 115% even after today's fall. Ruger shares, on the other hand, have risen "only" 45%.

This suggests that owners of Smith & Wesson stock may have much more to lose from a slowdown in gun sales in general, and handgun sales in particular. The fact that S&W shares cost 23 times earnings, versus 20 times earnings for Sturm, Ruger, further highlights the relative risk of the two stocks.

Thing No. 3: "Safety" on
Nor is P/E the only big difference between these two stocks. Despite strong profits, Smith & Wesson stock still hasn't seen fit to endow its shareholders with a dividend policy, whereas at Sturm, Ruger, shareholders can expect to collect a 2.5% annual dividend yield.

Sturm, Ruger boasts an additional margin of safety, in that the company's balance sheet currently boasts $69 million in cash, and no long-term debt at all. Smith & Wesson, in contrast, while it holds $54 million in cash, eclipses this safety buffer with a debt load three times as big: $175 million.

And one more thing...
All that being said, it's still worth pointing out that both these companies do have substantial cash positions, and their wealth is growing strongly. According to data from S&P Global Market Intelligence, for example, Smith & Wesson took in $132 million in free cash flow over the past 12 months, and Sturm, Ruger raked in a not-unimpressive $84 million in cash profits.

In each case, these numbers are well ahead of the companies' reported "net profits" as calculated according to GAAP. For the time being, therefore, it seems both companies are doing even better than might first meet the eye.

So what's the moral of this story? A Wall Street downgrade can be a frightening event for shareholders -- and three downgrades in a row, even more so. That being said, a one-month blip in NICS data may not be quite as scary as the analysts are making it out to be.

With Smith & Wesson shares currently trading for less than 10 times trailing free cash flow, I'm not sure I'd be too quick to follow Wall Street's lead and throw in the towel on Smith & Wesson stock just yet. This stock may still have room to run.

The article Smith & Wesson Hit By a Triple-Downgrade: 3 Things You Need to Know originally appeared on Fool.com.

Fool contributorRich Smithdoes not own shares of, nor is he short, any company named above. You can find him onMotley Fool CAPS, publicly pontificating under the handleTMFDitty, where he's currently ranked No. 290 out of more than 75,000 rated members.The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.